Some food for thought
"A man may learn from his Bible to be a more thorough
gentleman than if he had been brought up in all the drawing-rooms in
London."
—Charles Kingsley (English clergyman, 1819-1875)
Word for the day
Hangdog (adj)
Browbeaten; defeated; intimidated;
First thought this morning
The Pakistan economy is facing one of its worst crises in past 7
decades. Growth is collapsing, unemployment rising, inflation is high, interest
rates are prohibitive, current account is worsening despite massive currency
devaluation, and reserves are ominously low.
While the government is negotiating a rescue package with IMF,
the people at large may not be willing to take the pain associated with such
package, e.g., fiscal tightening, higher taxes, further devaluation of
currency, cut in government spending (including the sensitive defense
spending), restructuring of Chinese Belt & Road debt etc.
The moot point is whether India is taking advantage of the
situation to sort out pending issues with Pakistan!
I would like to answer this in affirmative. It is visible that
funding starved mercenaries and their support groups in J&K are being
neutralized at accelerated pace, despite some desperate last ditch attempts by
them. Persistent refusal of Indian leadership to engage with Pakistan
counterpart must also be adding to the pressure to act Indian pre condition of
eliminating terror camps. Efforts to isolate Pakistan at various multilateral
fora are also visible.
Some may believe that it is not adequate and we must use this
opportunity for some direct action. I feel we are doing fine.
Chart of the day
Open the black box
In past 2yrs, since the IBC process started with RBI marking 12
largest default cases for immediate resolution, the progress has been rather
mix.
Only 3/12 (Bhushan Steel, Monnet Ispat and Electrosteel Steel)
of initial cases have been fully resolved so far. 2/12 cases (Lanco Infra and
ABG Shipyard) have been declared irresolvable and undergoing liquidation
process. The resolution in rest 7/12 cases has been impacted by frequent
judicial interventions, poor NCLT strength, and/or lack of credible bidders.
Technically, all these cases must have been resolved in maximum 180+90 day
period. Currently, about one third of the total 1140 odd cases pending for
resolution under IBC are facing delay beyond the statutory resolution period of
270days.
On positive side, by end of FY19, over 700 cases had been resolved under the IBC process. In
FY19 alone lenders realized ~Rs660bn from the resolved cases. It is estimated
that the recoveries may exceed Rs800bn in the current year FY20.
In 4QFY19 about
350 new cases have been filed for resolution under IBC. As number of new cases
is increasing and resolution process is getting delayed, the market is
naturally getting jittery. Any news (even unsubstantiated and unconfirmed) of
delay or default in repayment of debt and/or interest due thereon is causing
panic in market. It has led to irrational value destruction for investors in
many cases.
This will surely be seen as an excellent opportunity by handful
of "smart investors", but value destruction at this scale has
weakened the overall structure of the market. Market participants at large are
losing faith in market, threatening the whole "revival of domestic
investors' interest in equities" prognosis that supported the markets well
for past 3years. Diminishing flows in equity mutual funds in past 3months is
just a small reflection of this.
The market reaction to a totally frivolous petition filed
against India Bulls Housing Finance company also highlights the frightened
state of market participants. Sharp fall in prices of all public sector banks
after the brokerage firm UBS published a theoretical worst case scenario in NPA
accretion a couple of days ago is also a case in point.
Most of the lenders have indicated in their recent commentaries
that the NPA cycle may already have peaked in FY19, and from the current year a
gradual improvement must be visible. Even some worst case scenario reports are
indicating that NPA cycle may peak in the current year.
As an investor, I am faced with two questions here:
(a) Should I buy
PSBs which in my view are definitely on their way up to recovery?
I believe yes, I must invest. The reasons are rather simple -
most large PSBs are trading at valuation much lower than their long term
averages; earnings are improving; asset quality looks set to improve; processes
and controls are much stronger now as compared to 5yrs ago; government has show
commitment for professionalization of management (BoB is a good sample case);
consolidation has begun and is encouraging (SBI and BoB are good examples); CAR
is improving and clarity on RBI capital reserve position after Jalan committee
submits its report will improve further visibility of fresh capital infusion;
credit market is reviving; they may regain some of the market share lost to
NBFCs; setting up of more NCLT benches and evolution of judicial precedents may
expedite resolution process of default cases, etc.
(b) How the market
may be insulated from frequent knee jerk overreactions?
This is little complicated. I think the market participants,
regulators and experts need to work together on this. So far the financial
sector stress has been presented to the market as a black box.
This box needs to be opened, and
investors and traders need to be informed about the precise current situation,
potential risks and implications for the market.
For example, market participants must
know the "Equity" part of the stressed debt and the
"leveraged" part of it.
When a mutual fund scheme invests in
the bonds of a corporate, it is effectively the same as investing in equity
shares of that corporate. The asset management company that manages the MF
Scheme is under no obligation for service or repayment of corporate debt. It is
only an agent of the investors who have subscribed to the MF scheme. The risk
of default by corporate in servicing the debt is completely borne by the
investors. I refer to this as 'Equity" part of the stressed debt. Same is
the situation with fixed deposits and NCDs directly subscribed by the investors.
Any default in these has no implication for any other publically traded entity,
unless such entity is an investor in these instruments.
On the other hand, when an NBFC or Bank
lends to a corporate from the money borrowed from other lenders and depositors,
the risk of default is borne by the respective bank or NBFC. This is the
"Leveraged" part of the stressed debt. Any default in this part of
the debt has implications for the investors in the lender, as it remains liable
to pay to its lenders and depositors. Any default in leveraged part of the debt
could have cascading impact and affect a number of publically traded entities.
So, if a default is made to a MF
Scheme, ideally markets should not be rattled as much as we have seen in recent
past.
Secondly, if the market is
transparently informed that the total amount at risk in the six popular cases
(Essel group, Jet Airways, DHFL, India Bulls, ADAG, Adani group), that have
been frequently rattling the market, might not be more than 2-3qtrs profit of
lenders, the chances are that market may not overreact to the news of a 7 days
payment delay.
Another analysis that needs to be done
is the notional gains made by the buyers of stressed assets vs. the losses
incurred by the lenders.
For example, company X buys a stressed
cement plant at 0.5x the replacement value of Rs120bn, while the lenders lose
60% of the Rs100bn due to them. Since the buying entity is a healthy going
concern, the market should assess whether it should celebrate Rs20bn notional
gain to the buyer, Rs60bn (0.5x of Rs120bn) additional business to the lenders
or it should mourn loss of Rs100bn to lender 75% of which was already provided
in previous years.
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